About 15 years ago, I tried to create my first budget. Have you tried? How did it go?
When I first tried, I was married to my first husband. The one that was a youth pastor turned drug addict. If you haven’t read my riveting tale, you can read my story here. He had been out of work and, since he was using, money was disappearing before we could pay all the bills, even though I didn’t know it at the time. We eventually went to get help to pay the bills from a church one of our family members attended. The church members we met with agreed to pay some of our utility bills if we attended their finance class.
I was glad they had this requirement. It began my journey to understand and try to control my finances. This was something I had never been taught and was eager to do better with. However, the class only provided me enough education about managing money, to create a wobbly budget.
My first budget served only to show me how much income I needed to pay my bills every month. I was able to bring that in with the teaching job I had, but the “medical needs” of my husband often left us without enough to make ends meet. He told me he was going to the county hospital and getting treatments for an ulcer. If someone in the family really does need medication, that may be a priority over other bills. Sometimes you do have to make difficult priority decisions with what you decide to pay first.
Maybe you are in a similar situation, with your budget, but hopefully not with your spouse! Have you created a budget that you follow? Have you used a budget as a starting point to create a spending plan that guides your finances, just like I taught you in this post?
Now that you have a Spending Plan to guide you, one that you would call a thing of beauty, how do you know if it truly is? (A thing of beauty, that is.)
How do you know if you have a “good” spending plan?
Some answers I have heard before…
“I have money left over at the end of the month.”
“I am saving some money.”
Those are a good start. However, let me tell you what makes a GOOD spending plan.
A good plan starts with your gross monthly income. This is the money your employer gives you before taxes and other deductions are removed. Your gross income is your monthly 100%. A good plan breaks this 100% down into percentages and this is what will guide the Spending Plan that will help you rule the world, or at least get you started moving toward that goal.
The 70 – 20 – 10 Plan is the best plan to get started with
This plan is especially good for those who are just getting started with money management or those who are trying to get control of their finances again after a life event that threw it off track. Make this plan your first target. It is a perfect minimalist plan to get you started easily. You want to aim to limit your living expenses to no more than 70% of your monthly income, no more than 20% for minimum debt payments, and at least 10% of your income dedicated to savings. Be sure to download a template from my Resource Library that calculates the percentages for you as you create your budget and spending plan.
70% of your Income Limited to Living Expenses
Living expenses make up the bulk of what you spend each month. For this plan, your housing expense regardless of whether it is in the form of rent or mortgage will be part of the living expense category. Everything else you spend on each month is in this category, including taxes, insurance and other deductions removed from your check before you get it.
In my template is a list of possible living expenses you need to account for. Don’t forget to plan for expenses that only happen every so often, such as car maintenance, birthday gifts, Christmas, and any others you might have. You will want to set aside some money each month for these, so when you need the money you will already have it and don’t have to fill your credit cards or steal money from your grocery budget to get tires on your car.
Other expenses that are often forgotten are the recurring subscriptions and money for fun like entertainment and hobbies.
20% or Less of Your Income for Debt Payments
This percentage is a Debt to Income Ratio. It is calculated using the minimum monthly payment of the debts you are paying. In my financial counseling practice, I have my clients tell me all the time, “I don’t know the minimum because I always pay about $50 on that one. I don’t like to pay the minimum payments.” Then as I press further, I find they are paying about $50 on each of 4 credit cards, maybe doubling some minimums and just barely paying the others. Then I find out that they may be paying $200 a month to these 4 debts, but they are also spending about $250 each month with the cards. Are they getting ahead by paying more than the minimum payment? Of course not. Always start with the minimum payment and then apply any extra payment to one credit card at a time. That will make the most progress and save the most interest.
When calculating this percentage, be sure to include car loans, student loans, and even repayment of personal loans to Grandma or Dad. Use this ratio when you are considering taking on a new car loan or debt for any other reason. If the payment does not fall under your 20% ratio, then it is not a debt you can afford. If it pushes you beyond 20%, such as with a large car payment, you will need to reduce the percentage in another area of your budget. I suggest you attempt to reduce your living expenses and pay down some of the debt, so you can keep saving at least 10% per month.
10% or More of Your Income to Savings
This is the most important ratio for your Spending Plan and one you should implement as soon as you get your paycheck. Once you determine how much you plan to save each month, set up auto payments or transfers to your savings so your money goes to savings immediately upon receipt. The most common mistake people make with savings is to tell themselves, “I am going to try and save about $200 each month.” Then if it is still in the checking account at the end of the month, they might move it to savings, or just leave it there and end up spending it the next month. These are the people who wonder why their savings is not growing at all.
This part of your budget is saving to secure your financial future. You want to include retirement savings, emergency savings, and savings for short term goals here. It should all add up to at least 10% of your monthly budget.
70-20-10 is a Great Place to Start
Once you reach this ratio as a starting point, now you can adjust it and do even better with your money. If you have paid off some debt then you can increase your living expenses or savings. I, of course, suggest increasing savings first because this is where your money works for you. In a good savings account, you can earn interest making your $1 eventually turn into $2. This will also save you the interest you would pay when using credit cards rather than paying cash for large purchases.
Some of my clients like to keep their living expenses very low so they can have a high car payment because that is where they like to put their money. However, those people may take on a large car payment to pay it off in a 36-month loan instead of a 72-month loan and they usually pay extra to it each month as well. These people are often saving 30 – 40% of their monthly budget as well.
People actively building wealth know it happens when the Expense and Debt to income ratios are the lowest. They work hard to reduce these and increase their savings as they go.
Wherever you begin with your budget is ok. Work each month to adjust, refine, and move more toward the 70-20-10 plan until eventually, you can move to a better ratio yet.
I would love to hear what percentages you are starting with and what you plan to change to get to the 70-20-10 plan, then keep us updated as you move along!